KepREIT – OSK DMG

Most Undervalued Office REIT

We initiate coverage on Keppel REIT with a BUY. Using DCF with terminal growth rate assumption of 3.0%, blended COE of 9.3% (with a 3% risk-free rate, 0.8x beta and 7.88% equity risk premium), we arrive at a SGD1.66 TP. We expect KREIT shares to re-rate over the mediumterm, as its portfolio will likely benefit from Singapore’s low incoming supply of new commercial assets and its high-yielding Australian assets.

Strong income stream. With a weighted average lease to expiry (WALE) of 6.6 years and long term lease (>five years) accounting for 40% of its portfolio, coupled with revenue hedge for its Australian exposure, KREIT’s earnings downside risks appear limited.

Improving stock liquidity, better acquisition currency. The restructuring of Keppel Group’s holdings and its subsequent stake reduction in KREIT has helped improved the latter’s liquidity, with its estimated free float now at 46% (below 25% during its initial years). Not only does this allow greater investor participation, but it also enables greater capital flexibility for potential acquisitions.

Recent sharp share price drop an overreaction. Amidst the volatility in the capital markets since May – whereby the STI index fell 7% and the FSSTREIT index dropped 17.8% – KREIT suffered a 23.6% correction. We see this as overdone, as it implies an 88% decline in KREIT’s forward rental cycle, coupled with a 25% correction in the AUD, all of which points to an overreaction. Hence, we see an excellent opportunity to accumulate a great value REIT with substantial upside.

TP of SGD1.66 provides 35% upside potential. K-REIT is currently trading at a compelling 6.8% FY13F yield, at a substantial 15% discount against its peers Suntec REIT (SUN, NEUTRAL, TP: SGD1.78) and CapitaCommercial Trust (CCT, NEUTRAL, TP: SGD1.45), both trading at 5.8%. We initiate coverage on KREIT with a SGD1.66 TP, which implies a potential upside of 35%.